1997.

(Appeals by certificate from the judgment and order, dated March 1, 1976, of the Madras High Court in T.Cs Nos. 160 of 1969 and 239 of 1971).

(a) Income-tax---

----Capital gains---Transaction to avoid or reduce tax on capital gains---Sale of shares necessitated by provision in Companies Act prohibiting inter- company loans---Price for shares fixed by Central Government---Proviso to S.12-B(2) of Indian Income-tax Act, 1922, was not applicable---Indian Income-tax Act, 1922, S.12-B---Indian Companies Act, 1956, 5.295.

(b) Income-tax---

---Business loss---Guarantee---Company---Memorandum of association authorising guaranteeing of loans---Guarantee for loans taken by subsidiary company---Subsidiary company going into liquidation---Loss deductible in year in which final payment was received from liquidator.

(c) Income-tax---

----Business expenditure---General principles---Expenditure must be incidental to business---Holding and subsidiary companies---Ceiling on remuneration to Directors fixed under Companies Act ---Assessee-company paying remuneration in excess of ceiling to Directors of subsidiary companies---No nexus between payment and business of assessee-company-- Amounts paid were not deductible---Indian Income-tax Act, 1922, S.10(2)(xv)---Indian Income Tax Act, 1961, S. 37.

The assessee-company held shares in several companies. As on July 1, 1956, a sum of Rs. 1,85,16,000 was due to S.G., a subsidiary of the assessee-company, from the assessee-company. Under section 295 of the Companies Act, 1956, which came into force on April 1,1956, no company could, without obtaining the previous approval of the Central Government in that behalf, directly or indirectly, make any loan to a company, which was its holding company. In subsection (3) of section 295 it was provided that where any loan made by a lending company and outstanding at the commencement of the Companies Act, 1956, could not have been made without the previous approval of the Central Government if that section had then been in force, then the lending company had, within six months from the commencement of the Act or such further time not exceeding six months as the Central Government might grant for that purpose, to either obtain the approval of the Central Government to the transaction or enforce the repayment of the loan made. The liability of Rs. 1,85,16,000 to S.G. by the assessee-company was affected by the aforesaid provision and, therefore, it became necessary for the assessee-company to liquidate this liability, S.G. owed a sum of Rs.1,05,21, 750 to S. 'The assessee-company approached the Government of India for necessary approval to put through certain transactions of sale of shares held by it to S.G. in liquidation of the liability. S.G., in its turn, would discharge its liability to S by selling its holdings to S. The asses see-company as well as S.G. proposed to sell the shares at certain specified prices per share and sought the approval of the Central Government for such sale. The Central Government, in approving the sale, fixed its own prices and stated that the said fixation was without prejudice to any valuation of shares for purposes of capital gains. Thereafter, the shares held by the assessee-company in various companies in respect of which approval had been granted by the Central Government were transferred by the asses see-company to S.G. with effect from June 13, 1957, at the prices fixed by the Company Law Administration and S.G. sold part thereof to S. The transaction between S.G. and S was also at the same prices. In its return of income for the assessment year 1958-59, for the relevant previous year ended on June 30, 1957, the assessee-company claimed a capital loss of Rs.4,37,703 in respect of the above transactions. The Income-tax Officer, while making the assessment, however, arrived at Rs.6,95,082 as the net capital gains, after taking into account the capital gains and the capital loss arising to the assessee in these transactions. In the above computation, the Income-tax Officer had taken the capital loss at Rs. 14,46,955, in the case of shares of S.R.V.S. The assessee-company appealed against the assessment of the capital gains to the Appellate Assistant Commissioner. While the said appeal was pending, the Commissioner of Income-tax proceeded under section 33B of he Indian Income-tax Act, 1922, and revised the capital loss of Rs.14,46,955 allowed by the Income-tax Officer and considered that there was capital gain liable for assessment of Rs.3,91,579. This figure was directed to be substituted and the assessment of capital gains was revised accordingly. The assessee-company appealed to the Tribunal against this order of the Commissioner and the said appeal was allowed by the Tribunal and the order of the Commissioner of Income-tax was set aside and the method adopted by the Income-tax Officer was held to be proper. The Appellate Assistant Commissioner took up the appeals of the assessee for this and other years subsequent to the order of the Tribunal. Following the Tribunal's order, he worked out the capital loss in respect of the other shares under consideration and in effect accepted the assessee's claim of capital loss of Rs.4,37,703. The said order of the Appellate Assistant Commissioner led to appeals both by the assesses-company and the Revenue to the Tribunal. On the first occasion when the matter came up before the Tribunal, it remanded the case to the Appellate Assistant Commissioner and called for a specific finding whether the sales under consideration were effected with the object of avoidance of tax or reduction of liability to tax and also wanted the full value of consideration to be worked out, in case the first proviso to section 12-B (2) of the 1922 Act was held to be applicable the Appellate Assistant Commissioner observed that there was ample evidence to show that the sale of shares was a forced one and that the assesses-company had no option but to comply with the statutory provisions and that the evidence produced clearly established the assesses-company's contention that the sale was not motivated by any desire to avoid capital gains tax. He worked out the figures in accordance with the rules framed under the Wealth Tax Act and found that the prices fixed by the Company Law Administration were not very much different from the figures worked out by him. After receiving the report of the Appellate Assistant Commissioner, the Tribunal considered the matter again and held that the proviso to section 12-B(2) of the 1922 Act would not be invoked in the instant case as there was no evidence to support the view that the sales were effected with a view to avoid the provisions of section 12-B. The Tribunal accepted the contention of the assessee and held that the Revenue was not justified in computing the capital gains. On a reference, the High Court held that with regard to the sale price, the Company Law Administration worked out the figures in consultation with the Central Board of Revenue and when the asses see-company sold the shares at those prices, it could not validly be contended that the assesses-company transferred the shares at certain prices with the object of avoidance or reduction of liability to capital gains. On appeal to the Supreme Court by the assesses-company:

Held, dismissing the appeal, that the High Court had rightly construed the provisions contained in the proviso to section 12-B(2) of the 1922 Act and, in view of the finding recorded by the Appellate Assistant Commissioner, which finding was accepted by the Tribunal, that the object of the transaction was not to avoid or reduce the liability to capital gains, the said proviso was not attracted.

The company S.S.M., was originally a subsidiary of A, which was a subsidiary of the assesses-company. On and from February 1, 1954, the assesses-company purchased all the shares of SSM from A and S.S.M. thus, became the direct subsidiary of the assesses-company. S.S.M. had borrowed moneys from a bank and the assesses-company had guaranteed the loan to the said company by the bank S.S.M. went into liquidation, some time in 1955. When S.S.M. went into liquidation, the assesses-company, as guarantor, was required to clear those overdrafts in accordance with the terms of the guarantee. After adjusting the amount recovered from the liquidators, the sum due to the assesses-company from the liquidated company on account of the said overdraft was Rs.9,08,764. The assesses-company claimed deduction of this amount a loss which arose in the course of and incidental to its business in the assessment for the year 1958-59 relying on its memorandum of association which authorised it to be the guarantor, for the loans. There were receipts by the assesses-company in the course of the liquidation of S.S.M in later years. The total amount received came to Rs.4,85,508.28, spread over the relevant accounting years for the assessment years 1959-60 to 1962-63. The Income-tax Officer held that the loss in question did not arise during the course of or incidental to the business of the assesses-company and in his view, it was at best a capital loss. In making the assessments for the years 1959-60 to 1962-63, the Income-tax Officer treated the receipts from the liquidator as income as a protective measure. The Tribunal held that the assesses-company had guaranteed the loan in the course of carrying on its own business and the loss was clearly admissible as a deduction. But since the assesses-company had received the last of the payments from the liquidator in the previous year relevant to the assessment year 1962-63 it was held that the balance of Rs.4,23,256 remaining unrecoverable represented the real business loss allowable for the assessment year 1962-63. This was upheld by the High Court. On appeal to the Supreme Court by the Revenue.

Held, dismissing the appeal, that the assesses-company had incurred the loss in carrying on its own business, which included furnishing guarantees to debts borrowed by its subsidiary companies. The assesses-company could have ascertained whether there was loss in the transaction of guarantee only at the stage of final payment by the liquidators, which was received in the relevant previous year for the assessment year 1962-63 and it was allowable in that year.

The assesses-company was a bulk sharesholder in several companies and in the relevant year there were sixteen companies. The assesses-company was rendering certain common services to its subsidiaries by having (1) a finance committee; (2) a liaison office in Delhi; (3) an export promotion department; and (4) internal audit department. The directors of the assessee company were also directors/managers to the subsidiary companies. Under the service agreements between them and the concerned subsidiary company, they were entitled to payment of remuneration and also a certain percentage of the profits as commission. Similar service agreements had been entered into by other directors of the subsidiary companies who were not the directors of the assessee-company. In view of the provisions of section 198 of the Companies Act, 1956, fixing a ceiling on the overall managerial remuneration at 11 per cent. of the net profits of the company, it was not possible for the subsidiary companies to pay the contracted remuneration to the persons concerned. On April 4, 1959, the board of directors of the assessee-company passed a resolution whereby it was resolved that the remuneration payable to nine directors of the subsidiary companies would be paid to them in full in accordance with the terms of the contract, respectively, entered into by them and the amount in excess of the maximum amount permissible under the Companies Act, 1956, would be met by the assessee-company. Out of these nine directors, three were directors of the assessee-company and out of these three directors, two were members of the finance committee. None of the other six directors of the subsidiary companies was a member of the finance committee. In accordance with the said resolution, the assessee-company paid diverse amounts to the said directors and claimed deduction of the same as business expenditure. The Income-tax Officer rejected the claim but the Tribunal allowed it. On a reference, the High Court held that the purpose of the payment was only to take out the subsidiary from an inconvenient situation in which it found itself as a result of statutory change restricting, the remuneration payable to its director and that the expenditure had not been incurred wholly and exclusively for the business of the assessee-company and it could not be allowed as deduction. On appeals to the Supreme Court by the assessee:

Held, dismissing the appeals, that the High Court had rightly proceeded on the basis that there must be a nexus between expenditure and business of the assessee. The expenditure incurred in payment of managerial remuneration to the directors of the subsidiary companies could not be said to be expenditure incurred in carrying on the business of the assessee company of holding its investments. The assessee-company could hold its investments and earn its dividends without incurring this expenditure. Since the subsidiary companies were not obliged to distribute by way of dividends the entire profits earned on account of their managerial remuneration paid by the assessee-company and the assessee-company was only entitled to dividend from the subsidiary company as and when declared, it could not be said that there was a direct and immediate connection between the expenditure incurred and the business of the assessee-company. The alternative claim by the assessee-company for deduction in respect of the expenditure incurred by the assessee-company in respect of amounts paid to its own directors who were also the members of the finance committee had been rightly rejected by the High Court in view of the resolution passed by the assessee-company wherein the directors, whether they be the members of the finance committee or not had been treated as a class and with reference to all of them the assessee-company incurred the expenditure only because they could not be remunerated to that extent by the subsidiary companies. The fact that they were directors of the assessee-company and members of the finance committee was not taken into account in taking over the remuneration payable to them. The sums of Rs.4,37,066, Rs.90,896, Rs.1,08,978, Rs.1,18,102, and Rs.1,11,740 were not deductible in the assessment years 1958-59 to 1962-63, respectively.

CIT v. Amalgamations (P.) Ltd. (1977) 108 ITR 895 affirmed.

Amalgamations (P.) Ltd. v. CIT (1969) 73 ITR 380 (Mad.); Atherton v. British Insulated and Helsby Cables Ltd. (1925) 10 TC 155 (HL); CIT v. Chandulal Kashavlal & Co. (1960) 38 ITR 601 (SC); Eastern Investments Ltd. v. CIT (1951) 20 ITR 1; (1951) 21 Comp. Cas. 194 (SC); Indian Aluminium Co. Ltd. v. CIT (1972) 84 ITR 735 (SC); J.R. Patel & Sons (P.) Ltd. v. CIT (1968) 69 ITR 782 (Guj.); Tata Sons Ltd. v. CIT (1950) 18 ITR 460 (Bom.) and Travancore Titanium Product Ltd. v. CIT (1966) 60 ITR 277 (SC) ref.

K.N. Shukla, Senior Advocate (B.K. Prasad, C. Radha Krishna and Anil Srivastava, Advocates with him) for Appellant (in Civil Appeals Nos. 139 to 142 of 1980 and for Respondent in Civil Appeals Nos. 7 to 11 of 1980).

T.A. Ramachandran and K.R. Ramamani, Senior Advocates (Mrs. Janaki Ramachandran, Advocate with them) for Appellant (in Civil Appeals Nos.7 to 11 of 1980 and for Respondent in Civil Appeals Nos. 139 to 142 of 1980).

JUDGMENT

S. C. AGRAWAL, J.---These appeals, by certificate of fitness granted by the Madras High Court under section 66-A (2) of the Indian Income-tax Act, 1922 (hereinafter referred to as "the 1922 Act"), and section 261 of the Income Tax Act, 1961 (hereinafter referred to as "the 1961 Act"), read with Article 133 of the Constitution of India, are directed against the judgment of the said High Court (see (1977) 108 ITR 895), dated March 1, 1976, in Tax Cases Nos. 160 of 1969 and 239 of 1971 (References Nos.52 of 1969 and 100 of 1971). Tax Case No. 160 of 1969 related to the assessment year 1958-59, wherein two questions were referred by the Income Tax Appellate Tribunal (hereinafter referred to as "the Tribunal") for the opinion of the High Court. Tax Case No. 239 of 1971 related to the assessment years 1958-59 to 1962-63, wherein the Tribunal referred six questions for the opinion of the High Court. By the impugned judgment both the questions in Tax Case No. 160 of 1969 and ail the question, except question No.3,, in Tax Case No 239 of 1971 were answered by the High Court against the Revenue and in favour of the assessee. Question No.3 in Tax Case No.239 of 1971 was answered in favour of the Revenue and against the assessee. Civil Appeals Nos.139 to 142 of 1980 have been filed by the Revenue in respect of the questions that have been answered against the Revenue and Civil Appeals Nos.7 to 11 of 1980 have been filed by the assessee in respect of question No.3 in Tax Case No.239 of 1971 which has been answered against the assessee.

We will first take up Civil Appeals Nos. 139 to. 142 of 1980 filed by the Revenue. These appeals can be split up into two parts, one relating to the answers to the two questions in Tax Case No. 160 of 1969 and questions Nos.1 and 2 in Tax Case No.239 of 1971, and the other relating to answers to Questions Nos.4, 5 and 6 in Tax Case No. 239 of 1971. The two questions in T.C. No.160 of 1969 and questions Nos.l and 2 in Tax Case No.239 of 1971 were as fellows:

Tax Case No. 160 of 1969 (page 905):

(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in upholding the basis of valuation adopted by the income-tax Officer for the shares in Sri Rama Vilas Service (Private) Ltd. as on January 1, 1954?

"(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the proviso to section 12-B(2) has no application in regard to the sale of shares to Simpson & Company Ltd.?"

Tax Case No. 239 of 1971 (page 905):

"(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the proviso to section 12-B (2) has no application in regard to the sale of various shares by the assessee-company to, Simpson & Company Ltd. through Simpson and General Finance Co. (,Private) Ltd. and that the assessee was entitled to a capital loss of Rs.9,47,541 in the assessment year 1958-59?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the second proviso to Tribunal 12-B (2) had no application and that the full value of the consideration accounted for by the assessee should not be altered?"

These questions arise in the following facts and circumstances:

Amalgamation (Private) Limited (hereinafter referred to as "the assessee-company") is a company incorporated on December 22, 1938, as a private limited company. The assessee-company held shares in several companies, such as Simpson & Company Ltd., Addison & Company (Pvt.) Ltd., George Oakes (Private) Ltd. Addison Paints and Chemicals (Private) Ltd., India Pistons (Private) Ltd., etc. Out of the issued capital of 7,50,000 shares of Rs.10 in Simpson & Company Ltd., the assessee-company held, at the material time, 7,06,933 ordinary shares. Simpson & Company Ltd. had a subsidiary by name Simpson and General Finance Company (Private) Ltd. carrying on the business of financing by way of hire purchase transactions to outsiders and by way of loans and advances to the companies of this group. As on July 1, 1956, a sum of Rs.1,85,16,000 was due to Simpson and General Finance Company (Private) Ltd. from the assessee-company. Under section 295 of the Companies Act, 1956, which came into force on April 1, 1956, no company could, without obtaining the previous approval of the Central Government in that behalf, directly or indirectly, make any loan to a company, which is its holding company. In subsection (3) of section 295 it was provided that where any loan made by a lending company and outstanding at the commencement of the Companies Act, 1956, could not have been made without the previous approval of the Central Government if that section had then been to force, then the lending company had to, within six months from the commencement of the Act or such further time not exceeding six months as the Central Government might grant for that purpose, either obtain the approval of the Central Government to the transaction or enforce the repayment of the loan made. The liability of Rs.1,85,16,000 to Simpson and General Finance Company Ltd. by the assessee-company was affected by the aforesaid provision and, therefore, it became necessary for the assessee-company to liquidate this liability. Simpson and General Finance Company (Private) Ltd. owed a sum of Rs.1,05,21,750 to Simpson & Company Ltd. The assessee-company approached the Government of India for necessary approval to put through certain transactions of sale of shares held by it to Simpson and General Finance Company (Private) Ltd. in liquidation of the liability. Simpson and General Finance Company (Private) Ltd., in its turn, would discharge its liability to Simpson & Company Ltd. by selling its holdings to Simpson & Co. Ltd. The assessee-company as well as Simpson and General Finance Company (Private) Ltd, proposed to sell the shares at certain specified prices per share and sought the approval of the Central Government for such sale. The Central Government, in approving the sale, fixed its own prices and stated that the said fixation was without prejudice to any valuation of shares for purposes of capital gains. Thereafter, the shares held by the assessee company in various companies in respect of which approval had been granted by the Central Government were transferred by the assessee-company to Simpson and General Finance Company (Private) Ltd. with effect from June 13, 1957, at the prices fixed by the Company Law Administration and Simpson and General Finance Company (Private) Ltd. sold part thereof to Simpson & Company Ltd. The transaction between Simpson and General Finance Company (Private) Ltd. and Simpson & Company Ltd. was also at the same prices.

In submitting its income-tax return for the assessment year 1958-59, the relevant previous year ending June 30, 1957, the assessee-company claimed a capital loss of Rs.4,37,703 in respect of the above transactions. In arriving at this loss, the assessee-company opted for the substitution of the market value as on June 1, 1954, in respect of shares in (1) S.R.V.S. (Private) Ltd., (2) Addison & Company Ltd., (3) George Oakes (Private) Ltd. and (4) India Pistons (Private) Ltd. As regards the rest of the shares, the assessee-company adopted the cost prices. The Income-tax Officer, while making the assessment, proceeded on the basis that the price structure approved by the Department of Company Law Administration for the transfer of the aforesaid shares was pure and simple on an ad hoc basis and meant to serve the limited purpose of approval to be given under section 372 of the Companies Act, 1956, and that the price at which the sales took place could not, therefore, be taken to represent the fair market value of the shares. He took the break-up value as on January 1, 1954, for the purpose of computation of capital gains and revised the sale prices and arrived at Rs.6,95,082 as the net capital gains. Even according to his computation there were certain capital losses which were adjusted as against the capital gains determined by him. In the case of S.R.V.S. (Private) Ltd., the Income-tax Officer took the break-up value as on January 1, 1954, at Rs.36,35,350 and their sale value at Rs.21,88,395 resulting in the capital loss of Rs.14,46,955.

The assessee-company appealed against the assessment of the capital gains to the Appellate Assistant Commissioner. While the said appeal was pending, the Commissioner of Income-tax Officer proceeded under section 33-B of the 1922 Act as he was of the view that the order of' the Income-tax Officer was erroneous and prejudicial to the interest of the Revenue in so far as he had wrongly allowed the capital loss amounting to Rs.14,46,955 on the sale of the shares in S.R.V.S. (Private) after considering the submission of the assessee-company, the Commissioner held that the appreciation in value of the shares of Simpson & Company Ltd. held by S. R. V . S. (Private) Ltd. should not have been taken into account and if the value of the shares held by S.R.V.S. (Private) Ltd. in Simpson & Company Ltd., as on January 1, 1954, had been Rs. 24,38,578, S.R.V.S. (Private) Ltd. would not have parted with these shares at cost on July 31, 1955. The Commissioner revised the capital loss of Rs.14,46,955 allowed by the Income-tax Officer and considered that there was capital gains liable for assessment of Rs.3,91,579. This figure was directed to be substituted and the assessment of capital gains was revised accordingly.

The assessee-company appealed against the said order of the Commissioner to the Tribunal contending that the sale value fixed by the Company Law Administration represented the correct value of the shares and the transactions were without any motive to avoid capital gains and they had been necessitated by the various provisions of the Companies Act which prohibited inter-company loans and that the method adopted by the Income-tax Officer, viz., the secondary valuation, was proper. The said appeal was allowed by the Tribunal and the order of the Commissioner of Income-tax was set aside and the method adopted by the Income-tax Officer of secondary valuation was held to be proper. The Appellate Assistant Commissioner took up the appeals of the assessee-company for this and other years subsequent to the order of the Tribunal and following the Tribunal's order he worked out the capital loss in respect of the other shares under consideration and in effect accepted the assessee-company's claim of capital loss of Rs.4,37,703. The said order led to appeals both by the assessee-company and the Revenue to the Tribunal. The assessee-company's appeal related to computation of the capital loss of Rs.4,37,703 as emerging from the order of the Appellate Assistant Commissioner instead of Rs.4,90,244 which would be the correct figure. The Revenue contested the acceptance of the claim of the assessee company with reference to the capital loss of Rs.4,37,703 as shown in the returns.

On the first occasion when the matter came up before the Tribunal, it remanded the case to the Appellate Assistant Commissioner and called for a specific finding whether the sales under consideration were effected with the object of avoidance of tax or reduction of liability to tax and also wanted the full value of the consideration to be worked out, in case the first proviso to section 12-B(2) of the 1922 Act was held to be applicable. The Appellate Assistant Commissioner observed that there was ample evidence to show that the sale of shares was a forced one and that the assessee-company had no option but to comply with the statutory provisions and that the evidence produced clearly established the assessee-company's contention that the sale was not motivated by any desire to avoid capital gains tax and that the Revenue had not proved by any conclusive evidence that the motive underlying the transaction was the avoidance or reduction of the liability to capital gains tax. He worked out the figures in accordance with the rules framed under the Wealth Tax Act and found that the prices fixed by the Company Law Administration were not very much different from the figures worked out by him. After receiving the report of the Appellate Assistant Commissioner, the Tribunal considered the matter again and held that the proviso to section 12-B of the 1922 Act could not be invoked in the instant case there was no evidence to support the view that the sales were effected with a view to avoid the provisions of section 12-B. The Tribunal accepted the contention of the assessee-company and held that the Revenue was not justified in computing the capital gains and disturbing the figures fixed by the Government of India. The two questions referred in Tax Case No. 160 of 1969 arise out of the proceedings under section 33-B of the 1922 Act, while questions Nos. l and 2 referred in Tax Case No. 239 of 1971 arise out of the order of the Tribunal in the appeal against the order of the Appellate Assistant Commissioner in respect of the assessment year 1958-59.

Since the second question in Tax Case No. 160 of 1969 and Questions Nos. 1 and 2 in Tax Case No. 239 of 1971 raise more or less the same issue, they were taken up together by the High Court. After referring to the provisions of section 12-B(2) and more particularly the first proviso to the said subsection, the High Court observed that the first requisite for the application of the said proviso, namely, that the person to whom the sale is made should be person with whom the assessee is directly or indirectly connected, was satisfied in the present case because the sale of shares to a subsidiary of the subsidiary is one to a person with whom the assessee company is directly or indirectly connected. As regards the second requirement of the proviso, as to whether the sale was effected with the object of avoidance or reduction of the liability of the assessee-company under the section, the High Court has pointed out that the Income-tax Officer had not given a finding that the object with which the transaction was put through was the avoidance or reduction of the liability to capital gains tax and the only observation that he had made in his order was that there was a reduction of liability to capital gains. According to the High Court, such a finding of taking the result as if it was the object, would not satisfy the requirement of the first proviso to section 12-B(2) of the 1922 Act. The High Court was of the view that the Tribunal had rightly called for a finding on this point specifically from the Appellate Assistant Commissioner referring to the finding recorded by the Appellate Assistant Commissioner, which was accepted by the Tribunal, that the object of the transaction was not to avoid or reduce such liability to capital gains tax, that the sale was a forced sale since the assessee-company had no option and that the prices had been fixed by the Company Law Administration, the High Court held that the first proviso to section 12-B(2) cannot be attracted to the present case. The High Court did not accept the contention urged on behalf of the Revenue that the sale price had been fixed by the Company Law Administration on as hoc basis and, in this context, it has observed that the letter, dated May 18, 1957 (Annexure-G.VII.A to the remand report of the Appellate Assistant Commissioner), clearly shows that the Company Law Administration worked out the figures in consultation with the Central Board of Revenue and when the assessee-company sold the shares at those prices, it could not be validly contended that the assessee-company transferred the shares at certain prices with the object of avoidance or reduction of liability to capital gains. On that view, the High Court answered the second question in Tax Case No. 160 of 1969 and the second question in Tax Case No.239 of 1971 in the affirmative and against the Revenue.

As regards the first question in Tax Case No. 160 of 1969 which raises the question of valuation, the High Court felt that on the view it had taken as regards the second question it would not survive for consideration because, the question of valuation would be material only if the proviso applied. The High Court has, however, considered the said question and has indicated the answer to that question also. The High Court has expressed the view that this is a case of substantial holding and that there is textual backing to the method adopted by the Income-tax Officer and that the Commissioner had found fault with it without any valid reason. The High Court, therefore, answered the first question in Tax Case No. 160 of 1969 in the affirmative and in favour of the assessee-company.

As regards the first question in Tax Case No.239 of 1971, the High Court felt that it did not require any independent treatment in view of the answer given with regard to second question in Tax Case No. 160 of 1969 which would answer that question also. Therefore, that question also was answered in the affirmative and in favour of the assessee-company.

We have heard Shri K.N. Shukla, learned senior counsel appearing for the Revenue, in support of the appeals in respect of the answers given by the High Court to these questions. Having considered the submissions of learned counsel, we are of the view that the High Court has rightly construed the provisions contained in the proviso to section I2-B(2) of the ! 922 Act and, in view of the finding recorded by the Appellate Assistant Commissioner, which finding was accepted by the Tribunal that the object of the transaction was not to avoid or reduce the liability to capital gains, the said proviso was not attracted. In our opinion, the said finding of the High Court does not suffer from any legal infirmity and there is no ground to interfere with the judgment of the High Court on this aspect of the case.

We may now take up the appeals of the Revenue in respect of question 'ins. 4, 5 and 6 in Tax Case No.239 of 1971.

The said questions were as follows (page 921):

"(4) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the loss sustained by the assessee on account of standing guarantee to Sembiam Saw Mills (Private) Ltd. (in voluntary liquidation) should be allowed in 1962-63 assessment after taking into account the amounts received from the liquidators during the years 1959-60 to 1962-63 ?

(5) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in deleting the receipts of Rs. 1,41,000, Rs. 2,29,627, Rs.1,10,500 and Rs. 4,381 from the liquidators of Sembiam Saw Mills (Private) Ltd. (in voluntary liquidation), from the assessments for 1959-60, 1960-61, 1961-62 and 1962-63, respectively ?

(6) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in folding that an amount of Rs.4,23,256 representing the real loss sustained by the assessee on account of standing guarantee of Sembiam Saw Mills (Private) Ltd. (in voluntary liquidation) should be allowed in the assessment for 1962-63?"

There was a company by name Sembiam Saw Mills (Private) Ltd. (for short "S.S.M."), which was originally a subsidiary of Addison & Company (Private) Ltd. On and from February 1, 1954, the assessee company purchased all the shares of S.S.M. from Addison and Company (Private) Ltd. and S.S.M. thus, became the direct subsidiary of the assessee company Sembiam Saw Mills (Private) Ltd. had borrowed monies from the National Bank of India Ltd., and the assessee-company had guaranteed the loan to the said company by the said bank. Sembiam Saw Mills (Private) Ltd. went into liquidation some time in 1955. For the purpose of overdraft facilities S.S.M: executed a promissory note in favour of the assessee company which was endorsed by the assessee-company to the bank along with a separate guarantee letter in favour of the bank. When S.S.M. went into liquidation, the assessee-company, as guarantor, was required to clear those overdrafts in accordance with the terms of the guarantee. After adjusting the amount recovered from the liquidators, the sum due to the assessee-company from the liquidated company on account of the said overdraft was Rs.9.08,764. The assessee-company claimed this amount as a loss which arose in the course of and incidental to its business, in the assessment for the year 1958-59. There were receipts by the assessee company in the course of the liquidation of S.S.M. in the later years. The total amount received came to Rs.4,85,508.28 spread over the relevant accounting years for the assessment years 1959-60 to 1962-63. The assessee company relied on the clause in the memorandum of association authorising it to be the guarantor for the loans and contended that the transactions in question sprang out of normal business transactions and hence the loss was an allowable deduction in the assessment for 1958-59. The Income-tax Officer held that the loss in question did not arise during the course of or incidental to the business of the assessee-company and in his view it was at best a capital loss which did not come within the scope of section 12-B of the 1922 Act. In making the assessments for the years 1959-60 to 1962-63, the Income-tax Officer treated the receipts from the liquidator as income, as a protective measure. In appeal, the Appellate Assistant Commissioner did not accept the claim of the assessee-company for allowance of the loss in 1958-59, as he was of the view that it was not a loss which arose during the course of or was incidental to its business. But the appeals for the years 1959-60 to 1962-63 were allowed in so far as they related to the question of the receipts in the respective years from the liquidator. As the guarantee loss had not been allowed as a deduction in 1958-59, the Appellate Assistant Commissioner held that the subsequent recoveries could not be included in the total income in the later years. The assessee-company as well as the Revenue preferred appeals against the said order of the Appellate Assistant Commissioner before the Tribunal. The Tribunal held that the assessee company had guaranteed the loan in the course of carrying on its own business and that the loss was clearly admissible as a deduction. But since the assessee-company had received the last of the payments from the liquidator in the previous year relevant to the assessment year 1962-63, it was held that the balance of Rs.4,23,256 remaining unrecoverable represented the real business loss allowable for the assessment year 1962-63. At the instance of the Revenue, the Tribunal referred the aforementioned question Nos.4, 5 and 6 for the opinion of the High Court.

The High Court, while dealing with said questions, has observed that the real point in issue was whether the guarantee that was executed in favour of the bank in respect of the loan to S.S.M., the subsidiary of the assessee-company, was done in the course of its

own business. The High Court has referred to its earlier judgment in Amalgamations (P.) Ltd. v. CIT (1969) 73 1TR 380 (Mad), wherein the nature of the business of the assessee company has been considered and it has been held that the provisions of section 23-A of the 1922 Act were applicable to the assessee-company since the assessee-company's business includes furnishing guarantees to debts borrowed by subsidiary companies. The High Court has held that the said finding given in that case is clearly applicable to the questions under consideration before it and that the assessee-company had incurred the loss in carrying on its own business which includes furnishing guarantees to debts borrowed by its subsidiary companies. According to the High Court, the loss was allowable as a deduction in the year in which it came to be ascertained and in the instant case the High Court held that the assessee-company could have ascertained whether there was loss in the transaction of guarantee, only at the stage of final payment by the liquidators which was received in the relevant previous year for the assessment year 1962-63 and that the Tribunal was right in allowing it in that year. The High Court, therefore, answered questions Nos. 4,5 and 6 in the affirmative and against the Revenue.

After hearing Shri Shukla on the appeals filed by the Revenue in respect of these questions, we are unable to hold that the judgment of the High Court in respect of these questions suffers from any legal infirmity. We, therefore, affirm the answer given by the High Court to questions Nos.4, 5 and 6 referred to it. In the circumstances, it must be held that Civil Appeals Nos. 139 to 142 of 1980 filed by the Revenue are liable to be: dismissed.

We would now come to Civil Appeals Nos. 7 to 11 of 1980 filed by the assessee-company in relation to question No.3 in Tax Case No. 239 of 1971, which was as under (page 908):

"(3) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the sums of Rs.47,066, Rs.90,896, Rs.108,978, Rs.1,18,102 and Rs.1,11,740 are admissible as a deduction in the assessments of the assessee for the assessment years 1958-59 to 1962-63, respectively?"

The assessee-company was a bulk shareholder in several companies and in the relevant year there were sixteen companies. The assessee-company was rendering certain common services to its subsidiaries by having (1) a finance committee; (2) a liaison office in Delhi; (3) an export promotion department and (4) an internal audit department. The expenditure on account of maintenance of the liaison office in Delhi and the departments of export promotion and internal audit was borne by the assessee-company and was recovered from the subsidiaries. The finance committee was working in an advisory capacity to the various subsidiary companies to help them to carry on their business more efficiently. All purchase requisitions for the purchase of capital equipment beyond Rs.500 of each purchase and Rs.2,500 with reference to purchase of raw materials were submitted to the finance committee for their approval. The purpose of such control was to judiciously use the funds of the company to the best advantage of each company. Various datas were gathered before such sanction was accorded or refused. Technical matters or other matters of management were also referred to the members of the finance committee who were experienced in their respective fields. The finance committee went through the financial position of each company daily. The directors of the assessee-company were also directors/managers in the subsidiary companies. As per the service agreements between them and the concerned subsidiary company they were entitled to payment of remuneration and also a certain percentage of the profits as commission. Similar service agreements had been entered into by other directors of the subsidiary companies who were not the directors of the assessee-company. In view of the provisions of section 198 of the Companies Act, 1956, fixing a ceiling on the overall managerial remuneration at 11 per cent. of the net profits of the company; it was not possible for the subsidiary companies to pay the contracted remuneration to the person concerned. On April 4, 1959, the board of directors of the assessee-company passed a resolution whereby it was resolved that the remuneration payable to nine directors of the subsidiary companies would be paid to them in full in accordance with the terms of the contract respectively entered into by them and the amount in excess of the maximum amount permissible under the Companies Act, 1956, would be met by the assessee-company. Out of these nine directors, three were directors of the assessee-company and out of these three directors, two were members of the finance committee. None of the other six directors of the subsidiary companies was a member of the finance committee. In accordance with the said resolution, the assessee-company paid diverse amounts to the said directors. The total amounts so paid to the several persons for the different years are mentioned in question No.3. The assessee-company claimed the said amounts as deduction under section 10(2) (xv) of the 1992 Act for the assessment years 1958-59 to 1961-62 and under section 37 of the 1961 Act for , the assessment year 1962-63. Before the Income-tax Officer it was not disputed that these payments were in respect of services rendered by the respective persons to the various subsidiary companies of which they were directors/managers and that no part of the payment could be related to any service directly rendered by them to the assessee-company. It was submitted that though the services were rendered by them to other companies, they should be deemed to have rendered the service to the assessee company, in view of the nexus between the holding company and its subsidiaries. The Income-tax Officer did not accept this submission and held that the excess remuneration over and above what was admissible under section 198 of the Companies Act, which was not borne by the respective companies, could not be allowed as deduction under section 10(2) (xv) of the 1922 Act and section 37 of the 1961 Act as expenditure wholly and exclusively incurred for the purpose of the business of the assessee-company. It was also stressed that the resolution of the board of directors of the assessee-company was passed on April 4, 1959, after the previous years relevant to the assessment years 1958-59 and 1959-60. On appeal, the Appellate Assistant Commissioner took the same view. The matter was remanded by the Tribunal to the Appellate Assistant Commissioner for consideration and submission of the report on the point mentioned in the order of remand. The Appellate Assistant Commissioner after taking further evidence submitted his report wherein he reported that deduction may be allowed in respect of remuneration paid to persons who were directors of the assessee-company and were members of the finance committee, but such deduction could not be allowed in respect of remuneration paid by the assessee-company in respect of persons who were only directors and employees of the subsidiaries, but neither directors of the assessee-company nor members of the finance committee. The tribunal was of the view that looking to the nature of the business of the assessee-company of holding shares of a number of subsidiary companies and that it was looking after the interest and welfare of those companies with a view to earn dividends, the whole of the expenditure referable to the remuneration paid by the assessee-company was admissible as a deduction.

Rejecting the contention urged on behalf of the Revenue that the assessee-company was not carrying on any business because merely holding investments would not constitute business, the High Court has held that in view of section 23-A of the 1922 Act the holding of investments, in appropriate cases, would equally be a business as dealing in them and what it required is that must be a real, substantial and systematic or organized course of activity or conduct with the set purpose of earning profit which is the test for a business. The High Court has observed that the assessee-company is not mere investor in a single company but has investments in sixteen companies and had taken active interest in the business of these companies as is clear from the services that had been rendered in the shape of export promotion, the liaison office at Delhi and internal audit and it also rendered consultation in respect of finance by its directors meeting every day with reference to the needs and requirements of each company and that it is not a case where the assessee-company contented itself with merely making an investment and looking for the dividend. The High Court has, therefore, held that there was a business activity in the matter of holding of investments While dealing with the question whither the expenditure that has been incurred was wholly and exclusively laid out for the purpose of the assessee-company's business, the High Court has negatived the contention that the said question is purely factual, because, in order to be deductible, the expenditure must satisfy two tests: (1) the expenditure must be incurred by the assessee in his capacity as a trader and (ii) it must be incidental to the carrying on of his business. The High Court was of the view that there must be a nexus between the expenditure and the business of the assessee. Applying these tests, the High Court has held that the purpose of the payment in the present case was only to take out the subsidiary from an inconvenient situation in which it found itself as a result of statutory change restricting the remuneration payable to its director and that the expenditure had not been incurred wholly and exclusively for the business of the assessee-company and it could not be allowed as deduction. The alternative claim put forward on behalf of the assessee-company that at any rate the expenditure incurred by the assessee company in remunerating its own directors who were also members of the finance committee should be allowed as deduction as there is a nexus between the expenditure and the business of the assessee-company in rendering services to its subsidiaries, was not accepted by the High Court for the reason that the resolution passed by the assessee-company does not say that the expenditure was incurred for the purpose of remunerating its own directors, in so far as they rendered services to it as members of the finance Committee. The High Court has observed that the resolution treated the directors, whether they be the members of the finance committee or not. as a class and with reference to all of them the assessee-company incurred the expenditure only because they could not be remunerated to that extent by the subsidiary companies and the fact that they were directors of the assessee company and that they were members of the finance committee had not been taken into account in taking over the remuneration payable to them. Question No.3 was, therefore, answered in the negative and against the assessee company.

The amounts paid by the assessee-company to the directors of its subsidiary companies can be admissible as a deduction under section 10(2)(xv) of the 1922 Act or section 37(1) of the 1961 Act, only if they can be regarded as expenditure "laid out or expended wholly and exclusively for the purposes of the business" of the assessee-company. This expression was also used in the Income-tax Act, 1918, in the U.K. In Atherton v. British Insulated and Helsby Cables Limited (1925) 10 TC 155 (HL), Viscount Cave L. C., has thus explained the said expression (page 191):

....a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade. "

These observations have been referred to with approval by this Court while construing section 10(2)(xv) of the 1922 Act. (See: Eastern Investments Ltd: v. CIT (1951) 20 ITR 1; CIT v. Chandulal Keshavlal & Co. (1960) 38 ITR 601).

In Travancore Titanium Product Ltd. v. CIT (1966) 60 ITR 277, this Court, while construing the expression "for the purpose of business" in section 10(2)(xv) of the 1922 Act, has said (page 282):

"The expenditure must be incidental to the business and must be necessitated or justified by commercial expediency. It must be directly and intimately connected with the business and be laid out by the taxpayer in his character as a trader. To be a permissible deduction, there must be a direct and intimate connection between the expenditure and the business, i.e., between the expenditure and the character of the assessee as a trader, and not as owner of assets, even if they are assets of the business."

In Indian Aluminum Co. Ltd. v. CIT (1972) 84 ITR 735 (SC), decided by a Constitution Bench of this Court, the aforementioned test laid down in Travancore Titanium Product Ltd. v. CIT (1966) 60 ITR 277 (SC), was qualified in these terms (page 747):

"In our view, the test adopted by this Court in Travancore Titanium's case (1966) 60 ITR 277 that to be a permissible deduction, there must be direct and intimate connection between the expenditure and the business, i.e. between the expenditure and the character of the assessee as a trader, and not as owner of assets, even if they are assets of the business needs to be qualified by stating that if the expenditure is laid out by the assessee as owner -cum-trader, and the expenditure is really incidental to the carrying on of his business, it must be treated to have been laid out by him as a trader and as incidental to his business."

The High Court, in our opinion, has rightly proceeded on the basis that there must be a nexus between expenditure and business of the assessee.

Shri T. A. Ramachandran, learned senior counsel appearing for the assessee-company, has submitted that the said test is satisfied in the present case since the purpose of the payment of remuneration to the directors of the subsidiary companies was to enable these companies to earn higher profits which would be passed on to the assessee-company as and by way of dividends. Learned counsel has placed strong reliance on the decision of the Bombay High Court in Tara Sons Ltd. v. CIT (1950) 18 ITR 460, anti the decision of the Gujarat High Court in J. R. Patel & Sons (P.) Ltd. v. CIT (196-8) 96 ITR 782, and has urged that the High Court has committed an error in distinguishing these cases on the ground that they related to managing agents, whereas the present case, relates to a holding company and its subsidiaries. Shri Ramachandran has contended that the principle laid down in the said decisions is equally applicable to a case of a holding company.

We are unable to accept this contention. The High Court, in our opinion, has rightly pointed out that the business of the assessee-company is the holding of investments and if with reference to the business of holding investments, any expenditure had been incurred that could have been allowed as deduction. The expenditure incurred in payment of managerial remuneration to the directors of the subsidiary companies cannot be said to be expenditure incurred in carrying on the business of the assessee-company of holding its investments. The assessee-company could hold its investment and earn its dividends without incurring this expenditure. Since the subsidiary company was not obliged to distribute by way of dividends the entire profits earned on account of their managerial remuneration paid by the assessee-company and the assessee-company was only entitled to dividend from the subsidiary company as and when declared, it cannot be said that there was a direct and immediate connection between the expenditure incurred and the business of the assessee-company. The decisions to Tara Sons Ltd. v. CIT (1950) 18 ITR 460 (Rom.) and J.R. Patel & Sons (P.) LTd. v. CIT (1968) 69 ITR '782 (Guj.) are not applicable to the facts of this case.

In Tata Sons Ltd. v. CIT (1950). 18 ITR 460 (Bom), the assessee was the managing agent of another company and under the managing agency agreement the assessee was to be paid a commission at a certain rate which was to be computed upon the net profits of the managed company. During the relevant years, the assessee paid voluntarily certain sums as half share of the bonus, which the managed company paid to some of its officers and it claimed deduction of the said amounts under section 10(2)(xv) of the 1922 Act. The Bombay High Court upheld the claim of the assessee for such a deduction on the view that from the point of view of commercial principles, what the assessee had done was something, which had as its object increasing the profits of the managed company and thereby increasing its own shares on commission and, therefore, the deduction claimed by the assessee was wholly and exclusively for the' purposes of its business and was an allowable deduction under section 10(2)(xv) of the 1922 Act. While dealing with the contention urged on behalf of the Revenue that the payment had been made not to the employees of the assessee but to the employees of a managed company-a different entity altogether-the High Court has observed (page 468):

"Here again if it can be shown that there was a very important nexus between the assessee-company and the managed company which necessitated the assessee -company making the payment to the employees of the managed company, then again it would be possible for the assessee-company to satisfy us that the expenditure was one which fell within the ambit of section 10(2)(xv). Now, it cannot be seriously disputed that the bonus was paid by the managed company to their employees in order to increase the efficiency of the working of the company. An increased efficiency of the company would incidentally result in higher and better profits, and the assessee company would be as much interested in the working of the managed company being more efficient as the managed company itself. Whatever tended to increase the profits of the managed company would also tend to increase the income and profits of the assessee-company. Therefore, it cannot be suggested that the assessee-company had an indirect or ulterior motive in making this payment. The only motive by which it was actuated was a purely commercial and pecuniary one and that was to see that more profits were made by the managed company so that its own commission should thereby be increased."

In that case there was a direct nexus between the increased profits of the managed company and the managerial commission payable to the assessee since the managing agency commission was prescribed percentage of the net profits of the managed company. As indicated earlier, there was no such nexus between the increased profit of the subsidiary company and the profit earned by the assessee-company by way of dividend on the shares held by it iii the subsidiary company.

In J. R. Patel & Sons (P.) Ltd. v. CIT (1968) 69 ITR 782 (Guj), the assessee was the managing agent and its managing director was also the director of the managed company. Prior to the coming into force of the Companies Act, 1956, on April 1, 1956, he was getting monthly salary from the assessee and in addition he was getting monthly remuneration as technical adviser of the managed company as well as commission at a prescribed rate on the sale price of heald and reeds manufactured and sold by the managed company. After the passing of the Companies Act, 1956, the remuneration that could be received by him was reduced and he could not also be paid the commission. The assessee, therefore, increased the emoluments. The said excess payment made by the assessee was disallowed and the expenditure incurred was restricted to the amount that was being paid prior to the coming into force of the Companies Act, 1956. The Gujarat High Court held that the assessee had paid extra payment to its managing director so that the affairs of the managed company could be properly looked after and that as a result of the remuneration, the profits of the managed company and the share of the commission of the assessee increased and, therefore, the excess amount paid by the assessee to its managing director was expended wholly and exclusively for the purpose of its business and was an allowable deduction under section 10(2)(xv) of the 1922 Act Reliance was placed on the decision in Tata Sons Ltd's case (1950) 18 ITR 460 (Bom). This was also a case where the profits of the assessee in the form of managing agency commission were directly linked to the profit of the managed company, which is not the position in the present case.

The alternative claim by the assessee-company for deduction in respect of expenditure incurred by the assessee-company in respect of amounts paid to its own directors, who were also the members of the finance committee has been rightly rejected by the High Court in view of the resolution passed by the assessee-company wherein the directors, whether they be the members of the finance committee or not, have been treated as a class and with reference to ail of them the assessee-company incurred the expenditure, only because they could not be remunerated to that extent by the subsidiary companies. The fact that they were directors of the assessee company and members of the finance committee was not taken into account in taking over the remuneration payable to them. In the circumstances, Civil appeals Nos. 7 to 11 of 1980 filed by the assessee-company are also liable to be dismissed.

In the result, Civil Appeals Nos. 139 to 142 of 1980 filed by the Revenue and Civil Appeals Nos. 7 to 11 1980 filed by the assessee-company are dismissed. No order as to costs.

M.B.A./1468/FCOrder accordingly.